We are excited to announce the addition of Jason Cummins to our Academic and Regulatory Advisory Council [click here].
Overall: “Participants generally noted that, given their individual outlooks for the economy, the labor market, and inflation, it may become warranted to increase the federal funds rate sooner or at a faster pace than participants had earlier anticipated,” said the Fed in their meeting Minutes. Stocks puked, the S&P 500 index reversing from Monday’s all-time high. Beneath the surface, those assets most geared to expectations of eternally easy financial conditions were savaged. Technology. Ethereum fell 20%. Stocks that gain when rates rise ripped higher as 2yr yields jumped 13bps on the week, 10yrs surged 25bps. “Some participants noted that it could be appropriate to begin to reduce the size of the Federal Reserve’s balance sheet relatively soon after beginning to raise the federal funds rate,” added the Minutes, surprising most traders who rushed to recalibrate their highly leveraged bets. But for all the portfolio reshuffling and stop-loss selling, not a single market participant doubted that the Fed stands ready to bail everyone out in a market crash. Such conviction is well-supported by decades of repeated behavior from our accommodating central bank. And yet this cycle appears different in many ways that seem sure to make the coming decade differ markedly from all but one or two in the past century. Ever since the early 1980s, inflation has been moderating. And since China’s 2001 WTO entry, globalization has suppressed real wage growth for labor in developed economies, while depressing goods prices. So much else has happened too. The disinflationary backdrop allowed the Fed to ease aggressively in each crisis, and tighten in a slow, predictable manner. But in a deglobalizing world that is now shockingly underinvested in energy production, the Fed may face a crisis accompanied by high inflation that could prevent the rapid easing etched into market psychology. And this is one of the greatest known risks we face in the year or two ahead.
Week-in-Review (expressed in YoY terms): Mon: GS asks US employees to WFH as Omicron surges, local media reports gov’t has ordered Evergrande to tear down apartment blocks in Hainan province, Tesla surpasses delivery expectations (308.6k cars delivered in Q4), Bolsonaro admitted to hospital with intestinal blockage related to 2018 stabbing, Biden affirms support to Ukrainian president, Elizabeth Holmes guilty on 4 out of 11 counts, Apple market cap exceeds $3T, Twitter permanently bans congresswoman Taylor Greene for repeated violations on spreading covid misinformation, Turkey inflation hits 19y high – 36.08% (27.36%e) / PPI 79.89% (68.1%e), S&P +0.7%; Tue: OPEC+ maintains 400k bpd increase in production for Feb despite US calls for greater increase, US reports over 1m new covid cases, Taiwan CB deputy gov says should consider hiking to rein in housing market, Turkey FinMin Nebati says developing new instruments to tame inflation, China Caixin Mfg PMI 50.9 (50e), Swiss CPI 1.3% (1.5%p), German unemp 5.2% (5.3%e), S&P -0.1%; Wed: Fed minutes express hawkish tone / discuss timing of rate hikes and QT and alternative approaches to removing policy accommodation, BoJ mulling over changing its view of downward price risks – would be the first hawkish adjustment in very long time, a PBOC publication warns businesses to offset any forex risks, HK bans flights from US + 7 other countries due to covid, ECB’s Kazaks says ready to act if infl outlook strengthens, Huarong dropped 55% as the troubled Chinese asset manager resumed trading after 9m suspension, Hungary unemp 3.7% (3.8%e), S&P -1.9%; Thur: Russia pledge to send troops to Kazakhstan to quell mass unrest in the country, Hungary CB unch for first week since beginning of Dec, Bullard says Fed could hike as early as March meeting, N. Korea tests hypersonic missile (2nd such test), Bolsonaro released from hospital after surgery, China Caixin serv PMI 53.1 (51.7e), Taiwan CPI 2.6% (2.7%e), EU PPI 23.7% (23.2%e), Brazil IP -4.4% (-4.1%e), German CPI 5.7% (5.6%e), US initial claims 207k (195k exp), US ISM services 62 (67e), US durable goods 2.6% (2.5%e), S&P -0.1%; Fri: NFP 299k (450k exp) / unemp 3.9% (4.1%e) / AHE 4.7% (4.2%e), Fed’s Daly says could imagine adjusting the balance sheet after 1-2 hikes, Kazakhstan’s president orders troops to “shoot to kill without warning” to quell mass anti-gov’t demonstrations, Taliban asks for emergency humanitarian aid, Japan FinMin warns about the perils of a weak ccy, Japan household spending -1.3% (1.2%e), Swiss unemp 2.6% (2.7%e), German IP -2.4% (-0.8%e), Norway IP 2.3% (6.9%p), France IP -0.5% (0.6%e), EU ret sales 7.8% (5.6%e), Mexico CPI 7.36% (7.45%e), Canada emp change 54.7k (25k exp) / unemp 5.9% (6%e), S&P -0.4%.
Weekly Close: S&P 500 -1.9% and VIX +1.54 at +18.76. Nikkei -1.1%, Shanghai -1.7%, Euro Stoxx -0.3%, Bovespa -2.0%, MSCI World -1.5%, and MSCI Emerging -1.2%. USD rose +19.9% vs Ethereum, +15.7% vs Bitcoin, +4.3% vs Turkey, +1.4% vs Russia, +1.1% vs Australia, +1.0% vs Brazil, +0.7% vs Indonesia, +0.4% vs Yen, +0.3% vs China, +0.1% vs Euro, and flat vs Canada. USD fell -2.7% vs Chile, -2.2% vs South Africa, -0.6% vs Mexico, -0.4% vs Sterling, flat vs India, and flat vs Sweden. Gold -1.7%, Silver -4.0%, Oil +4.9%, Copper -1.2%, Iron Ore +2.3%, Corn +2.3%. 5y5y inflation swaps (EU -10bps at 1.87%, US -8bps at 2.48%, JP +20bps at 0.64%, and UK +3bps at 3.97%). 2yr Notes +13bps at 0.86% and 10yr Notes +25bps at 1.76%.
Manufacturing PMI (high-to-low): Hungary 64.8 (previous month 52.2), Switzerland 62.7 (prev mth 62.5), Sweden 62.1/63.1, Italy 62/62.8, Czech Republic 59.1/57.1, Greece 59/58.8, US 58.7/61.1, Netherlands 58.7/60.7, Austria 58.7/58.1, Norway 58/63.9, UK 57.9/58.1, Germany 57.4/57.4, Canada 56.5/57.2, Spain 56.2/57.1, Poland 56.1/54.4, France 55.6/55.9, Taiwan 55.5/54.9, India 55.5/57.6, Japan 54.3/54.5, Indonesia 53.5/53.9, Vietnam 52.5/52.2, Turkey 52.1/52, South Korea 51.9/50.9, Russia 51.6/51.7, China 50.9/49.9, Hong Kong 50.8/52.6, Singapore 50.7/50.6, Brazil 49.8/49.8, Mexico 49.4/49.4, South Africa 48.4/51.7. Services PMI: Sweden 67.3/68.7, US 57.6/58, France 57/57.4, Spain 55.8/59.8, India 55.5/58.1, Ireland 55.4/59.3, UK 53.6/58.5, Brazil 53.6/53.6, China 53.1/52.1, Italy 53/55.9, Japan 52.1/53, Russia 49.5/47.1, Germany 48.7/52.7.
YTD Equity Indexes (high-to-low): Hungary +5.7% priced in US dollars (+2.4% priced in forint), Turkey +4.1% priced in dollars (+9.5% in lira), Poland +3.6% (+2.2%), Austria +3.3% (+2.9%), India +3% (+2.6%), Chile +2.8% (-0.3%), South Africa +2.6% (+0.3%), Czech Republic +2.1% (+0.1%), Singapore +2% (+2.6%), UK +1.7% (+1.4%), Ireland +1.5% (+1.8%), Israel +1.5% (+1.6%), Indonesia +1.4% (+1.8%), Saudi Arabia +1.4% (+1.3%), Italy +1.4% (+1%), Greece +1.2% (+1.5%), Finland +0.9% (+0.5%), Spain +0.8% (+0.4%), Germany +0.8% (+0.4%), France +0.7% (+0.9%), Argentina +0.5% (+1.1%), HK +0.4% (+0.4%), Norway +0.4% (+0.8%), Mexico +0.2% (-0.1%), Euro Stoxx 50 -0.1% (+0.2%), Taiwan -0.3% (-0.3%), Belgium -0.3% (-0.1%), Canada -0.6% (-0.7%), Colombia -0.8% (-1.2%), Thailand -0.8% (0%), Sweden -0.8% (-0.8%), Switzerland -1.1% (-0.6%), Venezuela -1.1% (-0.4%), Australia -1.2% (+0.1%), UAE -1.3% (-1.3%), Russia -1.4% (-0.4%), Netherlands -1.4% (-1.2%), Japan -1.5% (-1.1%), Korea -1.5% (-0.8%), New Zealand -1.6% (-0.5%), MSCI World -1.7% (-1.7%), S&P 500 -1.9%, China -2% (-1.7%), Philippines -2.1% (-1.6%), Malaysia -2.7% (-1.6%), Russell -2.9%, Portugal -3% (-2.8%), Brazil -3.2% (-2%), NASDAQ -4.5%, Denmark -6.1% (-6.4%).
Casinos: “This all started when Powell got renominated,” said the CIO. “The Paul Krugman’s of the world who influence Biden didn’t want hawkish rhetoric,” he said. “But remember, the Fed is a credible institution. Many pundits call its Governors stupid, but the Fed is no such thing. It will move, if need be,” he said. “And there is a bit of anchoring associated with the fact they have been fighting deflation for a decade and consistently underestimated the forces that kept prices low and stable. So sure, they’ll ultimately err on the side of being less hawkish than in previous hiking cycles.”
Casinos II: “Financialization of the economy is so extreme that it doesn’t take many rate hikes to have a meaningful effect on the economic system anymore,” continued the same CIO. “When you financialize your economy, and it is leveraged to your financial system as it is in the US, then you don’t need much tightening to slow the economy.” You certainly don’t need 5% overnight rates. “In this cycle, the Fed can achieve the same outcome as in previous cycles with more modest changes in rates and liquidity. It is on the march and it started a couple months ago, through the expectations channel.”
Casinos III: “Most people don’t understand how important the expectation channel is,” explained the CIO. “When your economy becomes a casino, players in the casino have outsized control over the economic system in that their forward expectations and bets start the tightening process before the actual rate hikes begin.” All the Fed needs to do is announce it is going to adjust liquidity conditions. “The betting market becomes a bigger part of the economic system. We’re not a manufacturing economy anymore, the US is a casino. And the tightening has started even as the Fed is still buying bonds.”
Collisions: “This year will be messy, volatile, far sloppier than previous years,” said the CIO. “First the market must adjust to the shift in the Fed’s stance, which will punish the most speculative corners of the financial system,” he said. “But that phase is well underway. The least profitable tech stocks excluding the FAANGs have been savaged.” Square is off 50% from all-time highs, its chart looks more like Ethereum’s than Apple’s. “This year, or at least this quarter, will be all about rotation, and beneath the averages there will be further carnage,” he said. “But we’ll find our level, markets always do.”
Collisions II: “Then next year we will enter a political dynamic unlike anything we’ve seen in a 100yrs,” continued the same CIO. “I’m glad there is so much editorializing about the political risks that are rising now. But I’m not sure even that can change the outcome. When you see the dominos line up, there is a certain inevitability to the change that is coming,” he said. “It’s almost like the housing crisis. In 2006 it was obvious that the housing market would crash.” But it took two years. “Now it is obvious that we are headed toward a catastrophic political collision. It’s so obvious but few people want to really admit it.”
Anecdote: “A massive technological shift is unmooring the center,” said the CIO. “Centralized authority and control are being eroded, undermined,” he added. “Our changing information systems are at the heart of this adjustment, making it increasingly difficult to establish truth, facts. And we have massive shifts to our energy delivery systems, biotechnology, our monetary systems.” The meaning of money is being questioned. “These shifts are undermining our institutions – government, education, economic and financial. Technology is shaking them all to the core. And as we move into this digital age, the employment base for huge swaths of society is being warped or obviated by technology at such dizzying speed that we are unable to process the change.” DeFi (decentralized finance) aims to replace the existing financial industry. Their payment systems alone will destroy roughly half the profits of the incumbent financial players. And that is just one example. Relative to what we were once accustomed to, such change is happening overnight. “Our brains evolved for a primitive existence and our institutions were built for life a few hundred years ago; new technologies are promising god-like power.” It is simultaneously exhilarating and terrifying. “And there is no greater incentive structure for the human species than to continue to press forward on innovation.” So this advance will not slow – the progress is relentless, accelerating. “We probably need a whole new set of institutions to meet the challenge of our new technologies, but not even the smartest people on the planet know what they should look like, let alone how to build and implement. And this is all unfolding in a highly leveraged world economy with inadequate supply chains and too little redundancy. It is optimized to a past that no longer exists.”
Good luck out there,
Chief Investment Officer
One River Asset Management
Disclaimer: All characters and events contained herein are entirely fictional. Even those things that appear based on real people and actual events are products of the author’s imagination. Any similarity is merely coincidental. The numbers are unreliable. The statistics too. Consequently, this message does not contain any investment recommendation, advice, or solicitation of any sort for any product, fund or service. The views expressed are strictly those of the author, even if often times they are not actually views held by the author, or directly contradict those views genuinely held by the author. And the views may certainly differ from those of any firm or person that the author may advise, drink with, or otherwise be associated with. Lastly, any inappropriate language, innuendo or dark humor contained herein is not specifically intended to offend the reader. And besides, nothing could possibly be more offensive than the real-life actions of the inept policy makers, corrupt elected leaders and short, paranoid dictators who infest our little planet. Yet we suffer their indignities every day. Oh yeah, past performance is not indicative of future returns.